Tune Up Your DC Plan in 2014

Similarly, defined contribution (DC) plan sponsors may wish
to tune up their plans in 2014 to protect them from common pitfalls. According
to Callan’s annual DC Trends Survey, reviewing plan fees and updating the
investment policy statement were popular activities for plan sponsors in 2013
as they sought to improve their fiduciary positioning. However, fiduciary flat
tires and other roadblocks to successful retirement continue to lurk undetected
in many DC plans.

Callan poses seven questions for DC plan sponsors to
consider as they check under the hood in the new year:

1. Is the investment policy statement (IPS) too hard to
handle? Sixty percent of DC plan sponsors updated their IPS in the past 12
months, and 95% did so within the past three years, according to Callan’s DC
Trends Survey. DC plan investment committees should review the IPS annually and
update it as needed. As fiduciaries at ABB, Inc. learned in a recent fee
lawsuit (see “There’s
a Limit to Reliance on Service Providers”), vague language in the IPS can
cause problems. Equally, an IPS that is too detailed to reasonably follow can
be a hindrance. The ideal IPS maps clear guidelines, creates a simple process,
provides a roadmap for making reasonable, long-term-oriented decisions, and
outlines easy-to-follow criteria to keep the investment committee on track.

2.
Is the fee payment approach past its prime? Plan sponsors are taking numerous
steps to calculate, benchmark, and reduce plan fees. However, few are
revisiting the way fees are paid: Only 12.5% of plan sponsors say they are very
likely to reduce or eliminate the use of revenue sharing to pay for plan
expenses in 2014, according to Callan’s DC Trends Survey. Given the increasing flexibility
of DC plan recordkeepers when it comes to fee payment approaches, plan sponsors
may wish to evaluate whether revenue sharing-based, bundled fee payments remain
the best structure. Fixed fee payments that are tied directly to service levels
may be more transparent and easier to manage. Either way, wise plan fiduciaries
will want to document a fee payment policy, either as part of the IPS or as a
separate document.

3. Are target-date funds aligned? In early 2013, the U.S.
Department of Labor (DOL) effectively threw down the gauntlet and issued “Tips
for ERISA Plan Fiduciaries” for DC plan sponsors that select and monitor their
plan’s target-date funds. Specifically, the DOL recommended that plan
fiduciaries consider how well the target-date fund’s characteristics “align
with eligible employees’ ages and likely retirement dates,” and to consider
custom target-date funds. However, many plan sponsors may still view target-date
glidepaths as one-size-fits-all: nearly half of DC plans simply offer the
target-date fund that is proprietary to the plan’s recordkeeper, according to
Callan’s DC Trends Survey. Fiduciaries may wish to revisit their target-date
fund in 2014 to make sure its glidepath suits the demographics and needs of the
DC participant population—and to document this due diligence.

4. Do the investment vehicles need bodywork? Most DC plans
use mutual funds to populate their fund lineup, but these investment vehicles
are not the only game in town. Non-40 Act funds can provide better fee
structures for plans at surprisingly low asset levels. For example, a DC plan
that has $50 million to invest with a broad style small-cap manager would find
the median institutional mutual fund’s fee is 1.05%. By comparison, a
comparable collective trust runs just 85 basis points, and a separate account
is 82 basis points, according to Callan’s fee database. (Note that these non-40
Act fund fees only reflect investment management expenses and separate accounts
are subject to extra charges for trust and custody, trading, and audit fees.)
Opening up the fund to collective trusts and separate accounts would also
increase the opportunity set of available investment managers—and possibly improve
diversification potential.

5. Are auto features stuck in neutral? A common rule of
thumb for a comfortable retirement is to save 10% to 15% of pay throughout
one’s career. Unfortunately, many DC plans automatically enroll employees at a
mere 3% of pay and auto increase them over time to just 6%. Many employees
allow their deferrals to remain at these low levels, meaning savings may be
stuck in neutral—and not geared for a financially secure retirement. Plan
sponsors using auto features can examine the savings patterns of their
participants: if participants fail to move away from low default deferral
rates, it is probably time to switch to a higher gear. Robust implementation of
automatic enrollment and automatic contribution escalation among respondents in
Callan’s DC Trends Survey include plans with a 12% default contribution rate
that auto escalates 2% annually to 16%; a default of 6% that auto escalates 1%
annually to 25%; and a 4% default that auto escalates 2% annually to 15%. Of
course, some plans may need to restructure their employer matching contribution
to ensure that the new default deferrals are affordable to the company.

6. Is the DC plan leaking? Research by DCIIA and EBRI found
that DC plan leakage in the form of cashouts can materially reduce the
probability of replacing a sufficient level of income in retirement (see“Plan
Leakage Can Derail Workers’ Retirement Savings”). Yet Callan’s DC Trends
Survey finds nearly half of plan sponsors do not have a policy to retain plan
assets, and many actively do not seek to retain the assets of retirees and/or
terminated employees. Plan sponsors might reconsider: retaining the assets of
inactive employees can boost economies of scale, affording cheaper investments
for all plan participants. If asset retention is simply not a goal, plan
sponsors can consider simple ways to facilitate rollovers in order to keep DC
money in the retirement system.

7. Could participant communications be misfiring?
Ineffective or poorly designed participant communication can result in
indifference or worse, it can actually discourage workers from saving. Plan
sponsors say in 2014, they will focus on communicating to employees about plan
participation, investing, contribution levels, and retirement income adequacy,
according to Callan’s DC Trends Survey. With so much on their plate, and
communication budgets tight, plan sponsors would do well to require metrics
from their recordkeeper or communications consultant that demonstrate the
effectiveness of participant communications. These metrics can help plan
sponsors refine and target their communications strategy.

Lori Lucas, CFA, Callan’s Defined Contribution
Practice Leader

NOTE: This feature is to
provide general information only, does not constitute legal advice, and
cannot be used or substituted for legal or tax advice.